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Understanding Tax-Loss Harvesting: An Investment Strategy to Minimize Your Tax Burden

Market volatility and downturns have been very significant so far this year. While negative performance is never the desired outcome, there is a strategy that can help offset the impact of losses by generating tax savings. The tax-savvy investment strategy is called “tax-loss harvesting” and it can be a very useful tax planning tool to increase the after-tax return in a portfolio.

Tax-loss harvesting is done by selling an investment that has decreased in value since the time it was purchased, thus recognizing the loss from a tax perspective, and then reinvesting those proceeds into an investment with similar characteristics. The realized losses can then be used to offset other realized capital gains or deduct ordinary income by up to $3,000 per year or $1,500 if married and filing separately. If the realized losses are more than the amount that can be offset from gains or deducted from income, they become “carryover losses” and will be applied to each year following until they are fully utilized.

There are a few important tax-loss harvesting rules and considerations to be aware of:

  1. This only applies to taxable investments. Tax advantaged accounts like IRAs, 401(k)s, 403(b)s etc. are not taxed on investment growth or income so realizing losses does not provide any benefit.
  2. If you realize a loss from an investment and then reinvest in a “substantially identical” investment within 30 days before or after something called a “wash sale” is triggered. If this happens you cannot deduct the losses from the sale. Wash sales can still be triggered even if the identical position is purchased in a retirement account. It is possible to avoid the wash sale rule without changing your investment allocation in a significant way by investing in a replacement mutual fund or ETF that is different, but targets the same geographic, size, quality characteristics as the investment that was sold.
  3. The benefits of tax loss harvesting increase with your tax rate. For instance, if you can offset income that is taxed at 35% now, assuming what it was reinvested in goes up and is held for over a year, the maximum long-term capital gains rate is currently 23.8%. That difference and the deferral of paying tax on it is the net benefit.

Tax-loss harvesting can be a very beneficial wealth management tool for investors if they are able to take advantage of it and execute on a plan. When markets are experiencing significant volatility, missing a positive day has the potential to be impactful. Rebalancing to target portfolio allocations during times like these are also important for improving overall performance and can work in tandem with tax-loss harvesting.

If you’re looking for expert ways to maximize your returns by minimizing your tax exposure, we’re here to help guide you.


Important Disclosure Information:

Different types of investments involve varying degrees of risk, including the risk of loss of your entire investment. Past performance is not indicative of future results. CPWM and its employees can give no assurance that the performance of any specific investment recommendation or investment strategy discussed herein, whether directly or indirectly, will be profitable, or that it will be equal to any historical performance level discussed herein. The discussion or information contained herein is not intended to be, and should not be deemed as, personalized investment advice. The recommendations made may not be suitable for your specific individual situation and we encourage you to discuss with your financial professional before undertaking any investment strategy or recommendation contained herein. The discussions contained in this blog is current only as of the date hereof and may change due to a number of factors, including varying market conditions.